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Chapter 16: Dilutive Securities and Earnings per Share (Dilutive…
Chapter 16: Dilutive Securities and Earnings per Share
Dilutive Securities & Compensation Plans
Debt and Equity
Many of the controversies related to the accounting for financial instruments such as share options, convertible securities, and preference shares relate to whether companies should report these instruments as a liability or as equity
we discuss securities that have characteristics of both debt and equity
Convertible securities, options, warrants, and other securities, are often called dilutive securities because upon exercise they may reduce (dilute) earnings per share.
Convertible Debt
Convertible bonds can be changed into other corporate securities during some specified period of time after issuance.
Corporations issue convertibles for two main reasons
to raise equity capital without giving up more ownership control than necessary
to obtain debt financing at cheaper rates
Accounting for Convertible Debt
with-and-without method
FV of Convertible Debt - FV of Debt Component (PV of future CF) = FV of Equity Component
Accounting at Time of Issuance
Cash (db),
Bonds Payable (cr),
Share Premium-Conversion Equity (cr)
Settlement of Convertible Bonds
Repurchase at Maturity
Bonds (db), Cash (cr)
Conversion of Bonds at Maturity
Share Premium-Conversion Equity (db),
Bonds Payable (db),
Share Capital-Ordinary (cr),
Share Premium-Ordinary (cr)
Conversion of Bonds before Maturity
Share Premium-Conversion Equity (db),
Bonds Payable (db),
Share Capital-Ordinary (cr),
Share Premium-Ordinary (cr)
Repurchase before Maturity
Bonds Payable (db),
Share Premium-Conversion Equity (cb),
Loss/Gain on Repurchase (db/cr),
Cash (cr)
Induced Conversions
Sometimes, the issuer wishes to encourage prompt conversion of its convertible debt to equity securities in order to reduce interest costs or to improve its debt to equity ratio.
Conversion Expense (db), Cash (cr)
Convertible Preference Shares
Convertible preference shares include an option for the holder to convert preference shares into a fixed number of ordinary shares
Issuance:
Cash (db),
Share Capital-Preference (cr),
Share Premium-Conversion Equity (cr)
Conversion (Book Value):
Share Capital-Preference (db),
Share Premium-Conversion Equity (db),
Share Capital-Ordinary (cr),
Share Premium-Ordinary (cr)
Repurchased (Fair Value):
Share Capital-Preference (db),
Share Premium-Conversion Equity (db),
Retained Earnings (db), Cash (cr)
Share Warrants
Warrants are certificates entitling the holder to acquire shares at a certain price within a stated period
Objective
to make the security more attractive
preemptive right to purchase ordinary shares
as a form of compensation for executives and employees
Share Warrants Issued with other Securities
Issuance
Cash (db), Share Premium-Share Warrants (cr)
Cash (db), Bonds Payable (cr)
Excersise
Cash (db),
Share Premium-Share Warrants (db),
Share Capital-Ordinary (cr),
Share Capital-Premium (cr)
Failure to Excersise
Share Premium-Share Warrants (db), Share Premium-Expired Share Options (cr)
Rights to Subscribe to Additional Shares
Issuance
Companies make only a memorandum entry when they issue rights to existing shareholders.
Excersise
Cash (db),
Share Capital-Ordinary (cr),
Share Premium-Ordinary (cr)
Share Compensation Plans
a share option, which gives key employees the option to purchase ordinary shares at a given price over an extended period of time
intrinsic-value method
the difference between the market price of the shares and the exercise price of the options at the grant date
fair value method
use acceptable option-pricing models to value the options at the date of grant.
Accounting for Share Compensation
Share-Option Plans
Determine Expense
using an option-pricing model, with some adjustments for the unique factors of employee share options
Allocating Compensation Expense
recognizes compensation expense in the periods in which its employees perform the service (service period/vested period
Restricted Shares
Employee Share-Purchase Plans
Disclosure of Compensation Plans
Debate over Share-option accounting
Computing Earnings per Share
Simple Capital Structure
Complex Capital Structure